Investors Brace for the Choice of Japan’s New Central Bank Governor

Investors worldwide are on tenterhooks ahead of the choice—thought to be just days away—of Japan’s next central bank governor.

Prime Minister Shinzo Abe’s decision could be one of the most significant events of 2013 for Japanese stock and currency markets, investors say, because a new governor who’s determined to ease monetary policy much more aggressively could not only help revive the country’s economy but also pump much more cash into financial markets by snapping up assets.

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Eeny, meeny, miny, moe . . .

Generally, the appointment of an aggressive easer would likely weaken the yen and boost share prices, which have already moved significantly in the past three months on expectations of more monetary easing.

Stock and currency investors are particularly jittery, some hedge funds say, since the unveiling of the candidate’s name is likely to come at a tricky time, the yen’s weakening and the rise in Japanese share prices having slowed and concerns about the Chinese and European economies having resurfaced.

Investors say they also view Mr. Abe’s choice of a governor as a signal of how determined he is to go through with his mix of fiscal and monetary stimuli with pro-growth strategies—dubbed “Abenomics.”

“So far expectations about Abenomics have been all-powerful, but this will be the moment of truth,” Norihiro Fujito, senior investment strategist at Mitsubishi UFJ Morgan Stanley Securities Co. said.

Mr. Fujito said investors are watching whether Mr. Abe can overcome opposition from both the powerful Ministry of Finance and the central bank itself to pick a governor aggressive enough to try easing measures that have not been tested in Japan before.

Of the names floated, investors have been skeptical about Toshiro Muto, a former finance-ministry official and BOJ deputy governor, who they say is unlikely to stray far from conventional easing steps, such as increases in the BOJ’s existing asset-purchase program. If Mr. Muto is chosen, Mr. Fujito projects that the Nikkei Stock Average will fall to below 10500, a 7.8% drop from Friday’s closing level of 11385.94.

When some reports last week suggested that Mr. Muto had become the clear front-runner, the yen strengthened against the dollar, while shares fell.

Matthew Cobon, a fund manager at U.K.-based Threadneedle Asset Management Ltd., said he’s been building a small trading position that assumes the yen will strengthen, and so hopes Mr. Muto gets the slot.

“At the margin, it would be helpful to my view if Muto was appointed,” said Mr. Cobon. A candidate like Mr. Muto, seen as less aggressive, would spook traders betting the yen will continue weakening, he said.

With Mr. Abe keenly aware of the recent market reaction, some traders are now betting that Mr. Muto’s candidacy is off the table.

Many strategists and fund managers say the candidate most likely to result in a weaker yen and stronger stock market is former BOJ Deputy Gov. Kazumasa Iwata. He’s known as a proponent of radical easing measures, such as having the central bank buy foreign bonds or increase purchases of riskier assets like exchange-traded funds and real estate investment trusts.

Christopher Wood, CLSA’s Hong Kong-based equity strategist, is telling clients that if a former finance ministry official is confirmed as the new governor, they should cash out of bets that the yen will continue to weaken. That’s because such former officials are unlikely to let the central bank buy foreign bonds, a measure that would weaken the yen.

Still, some hedge funds say that it’s unlikely that stocks and yen will move too radically, whomever is chosen, since the new governor will have to follow Mr. Abe’s aggressive easing stance. Other candidates include Haruhiko Kuroda, a former finance official who’s president of the Asian Development Bank, and Kikuo Iwata, an academic known for being highly critical of the policies taken by current BOJ Gov. Masaaki Shirakawa.

Michael Trace, who manages about $15 million in Japanese equities for Singapore-based Gordian Capital LLC’s Start22 Fund, said on Friday he increased positions betting that stocks will rise, even before Mr. Abe makes public his choice.

“The uncertainty is going to be cleared up. The risk is on the upside, not the downside,” Mr. Trace said, adding he thinks Mr. Kuroda is the most likely choice.

For the bond market, many market players say the appointment of the less-aggressive Mr. Muto would be most bullish for Japanese government bonds. That’s because the yen would strengthen again, pummeling the Japanese economy and spurring purchases of JGBs, which are seen as safe investments. The nomination of Mr. Ito or either of the two Mr. Iwatas, on the other hand, would likely further weaken the yen, and could push yields on longer—term JGBs higher, some investors say.

Ultimately, fund managers say market volatility linked to the BOJ nomination is likely to be short-lived, since traders are more interested in whether the new BOJ governor will deliver on the promise of bold policy action.

“Abe has created an environment where it is almost compulsory for the BOJ to do something different,” said Clive Dennis, a currency manager at Schroders PLC in London. “Just tweaking around the edges of the existing program would be very disappointing.”

About Japan Real Time

Japan Real Time is a newsy, concise guide to what works, what doesn’t and why in the one-time poster child for Asian development, as it struggles to keep pace with faster-growing neighbors while competing with Europe for Michelin-rated restaurants. Drawing on the expertise of The Wall Street Journal and Dow Jones Newswires, the site provides an inside track on business, politics and lifestyle in Japan as it comes to terms with being overtaken by China as the world’s second-biggest economy. You can contact the editors at japanrealtime@wsj.com